The portrait of Mahatma Gandhi is displayed on Indian rupee banknotes in an arranged photograph in Bangkok, Thailand. (Photographer: Brent Lewin/Bloomberg)

Record-Low Rupee Doesn't Scare India as Headwinds Build

(Bloomberg) -- India’s central bank stared down the rupee’s slide to a record low, opting to keep interest rates unchanged as it flagged risks to the economy from global monetary policy tightening, trade wars and surging oil prices.

In a surprise decision, the monetary policy committee led by Governor Urjit Patel voted 5-1 to leave the repurchase rate at 6.5 percent on Friday. The decision, which was predicted by just nine of 49 economists in a Bloomberg survey, sparked a selloff in the nation’s currency and stocks.

The Reserve Bank of India’s pause after two hikes since June is in contrast to its peers in Indonesia and the Philippines, who have pressed ahead with aggressive policy action to counter an emerging-market selloff triggered by higher U.S. rates and a stronger dollar. But in a clear indication that it’s not done with rate increases, the RBI changed its policy stance to “calibrated tightening” from the neutral that’s been in place since February 2017.

While the change doesn’t mean that every meeting will result in a rate hike, it does take rate cuts off the table, Governor Patel said. Lowering the inflation forecast to a range of 3.9 percent to 4.5 percent for the second half of the year ending March, from 4.8 percent previously, allows the MPC room to pause on rates, he said.

Inflation for now is well below the 4 percent midpoint of the central bank’s target range, even as the economy expands at a world-beating 8 percent plus pace.

“There are already forces at play that we expect will slow activity in coming quarters, including tighter financial conditions, higher oil prices and weaker global growth,” said Sonal Varma, chief India economist at Nomura Holdings Inc. and one of the nine economists who had forecast rates to remain unchanged. “Against this backdrop, the impact of cost-push factors should be limited and transient and, as the output gap again turns negative, underlying inflation should converge back towards 4.5 percent.”

Record-Low Rupee Doesn't Scare India as Headwinds Build

Undershooting

While headline inflation has eased in recent months, the core measure, which strips out volatile fuel, food and electricity prices, has been sticky at around 6 percent.

What Our Economists Say...
Looking ahead, we see inflation continuing to undershoot the RBI’s forecasts, as a widening output gap reduces price pressures. That should keep the RBI on hold in December, in our view.

-- Abhishek Gupta, Bloomberg Economics

For more, read our India React 

The central bank’s September survey on households painted a mixed picture about price pressures. While inflationary expectations for the three months ahead rose sharply by 50 basis points, a year down the line those expectations were lower by 30 basis points compared to the survey in June.

The decision by the RBI comes at a time when liquidity conditions have tightened and there are worries that defaults by a systemically-important financier could lead to a contagion. Authorities have moved to ringfence Infrastructure Leasing & Financial Services Ltd., while the RBI has pledged to inject $5 billion into the system through bond purchases as it tries to ease the liquidity squeeze.

Foreigners have pulled $9.7 billion from local shares and debt this year, adding to worries that India will struggle to bridge its swelling current-account deficit. The government has raised import tariffs while the central bank allowed companies to raise more money abroad, though those efforts haven’t stopped the rupee’s slide.

On Thursday, the government lowered duties on fuel, providing some relief to consumers while putting pressure on its budget goals.

Unfazed

Patel appeared unfazed by the sharp drop in the currency, saying the depreciation was helping to correct external imbalances. The RBI doesn’t have any target or band in mind and acts only to manage volatility.

“The unchanged decision suggests that the Reserve Bank of India is not overly concerned about rupee depreciation,” said Mitul Kotecha, a senior emerging-markets strategist at TD Securities in Singapore.

The rupee, which is the worst-performing major currency is Asia, has dropped about 7 percent since August when the RBI last raised rates. At the same time, prices of crude oil -- India’s biggest import -- rose more than 10 percent, a factor that is likely to drive headline inflation in coming months.

An increase in the price of oil to $96 a barrel could stoke inflation by 40 basis points above its estimate and damp growth by 30 basis points, the central bank said. Trading giant Mercuria Energy Group Ltd. said last month Brent crude may spike over $100 in the fourth quarter, amid concerns sanctions on Iran will shrink global supplies and as Venezuela’s industry continues to struggle.

The RBI lowered India’s economic growth projection for the first quarter of the 2020 fiscal year to 7.4 percent from the August projection of 7.5 percent, while retaining the current year’s forecast at 7.4 percent.

©2018 Bloomberg L.P.